The circular flow of income model is a theoretical representation of the economy. It shows the distribution of income within the economy and the interaction between the different sectors in a modern market economy. The five-sector model is a more elaborate model in comparison to the basic, two, three and four sector models. The model represents an economy like Australia and divides the economy into five main sectors.
The first sector in the model is the Households sector. This sector refers to all individual members in the economy. All individuals of an economy are consumers. Consumers are concerned with earning an income for themselves and spending on goods and services. Households supply factors of production i.e. land, labour, capital and enterprise and are rewarded with income in the form of rent, wages, interest or profit by the firms sector.
The second sector in the model is the Firms sector. This sector represents all of the business firms involved with the production and distribution of goods and services.
Firms contribute to the circular flow as it is in a business's best interest to obtain factors of production and use them to produce and sell goods and services.
The basic model is based on the assumption that the economy consists of only the Households and Firms sectors. Here, the model is overly and rather, unrealistically simplified so the consideration of the other sectors is absent. In this model, leakages and injections do not exist. It does not take into account the capital market, where savings by consumers and investment by firms are leakages and injections respectively. It also assumes that there is no government sector influencing the economy, meaning consumers pay no taxes as businesses do not receive any benefits nor do consumers receive any social security payments. The basic model also...
The circular flow model is defined as the flow of resources from households to firms and of products to firms from households. These flows are accompanied by reverse flows of money from firms to households and from households to firms. The circular flow is comprised of the resource market, households, product market, businesses, and the government.
Macroeconomics - The study of the aggregate (total) Behavior of the whole economy.
- Unemployment rate: Percent of people in the labor force is not working but searching for work.
- Inflation rate: Percent rise in the average price of all goods and services.
- GDP: Dollar value of all final goods and services produced within a country in a given year; output
A Market is an institution or mechanism which brings together buyers (demanders) and sellers (suppliers) of particular goods and services.
The Forces of supply and demand - In the United States and in other free enterprise systems, the distribution of resources and products is determined by supply and demand. Demand is the number of goods and services that consumers are willing to buy at different prices at a specific time. A fundamental characterisic of demandis all else being constant, as prices fall, the quantity demanded rises. Vice versa all ther things remaining the same as price increases, the corresponding quanity demanded falls.
Supply - The number of products-goods and services that businesses are willing to sell at different prices at a specific time. As price increases, the corresponding quantity supplied increases; as prices fall, the quantity supplied also falls.
Equilibrium Price - The supply and demand curves intersect at the point where supply and demand are equal. The price at which the number of products that businesses are willing to supply equals the amount of products that consumers are willing to buy at a specific point in time.
The United States and the economy -
The United States has the most powerful, diverse, and technological advanced economy in the world. Oriented economy, private individuals, and business firms make most of th decisions. Government purchases of goods and services are made predominantly in the marketplace. US business firms have greater flexibility than their counterparts in Western Europe and Japan in decisions to expand capital plant, lay off surplus workers, and develop new products. In all economic sectors, US firms are at or near the forefront in technological advances, especially in computers, medical equipment, and aerospace, although their advantage has steadily narrowed since the end of World War 2. The excelled technology explains the gradual development of a " two - tie labor market" in which those at the bottom lack the education and professional / technical skills of those at the top and, fail to get pay raises, health insurance coverage, and other benefits.
The circular flow - The continuous movement of production, income, and resources between producers and consumers. This flow moves through product markets, as the gross domestic product of our economy and is the revenue received by businesses in payment for this production. The flow of revenue flows to resource markets as payments by businesses for the resources employed in production. The payment received by resource owners is income. Resource owners use this income to purchase goods and services through the product markets. This flow can be altered in a number of different ways, especially by government. Taxes are sliced by income, wages, profit, etc., but are then used for expenditures by government on other things bought through the product markets. Consumers also divert a portion of their income into saving, which is then used to finance the federal deficit or business investment. For every buyer there is a seller, The seller receives what the buyer buys, The buyer gives money for goods and the seller gives goods for money.
National income is the total value of all factor payments during a period of time. Thenational income is a measure of the total economic flow through the factor marker. Gross national product should equal the national income. GDP is the total market value of all final goods and services produced during a given period and time within the nations borders. Gross domestic product is the most common measure of the level of economic activity at the national level.
Households own the economy's resources ( Factors of production; land, labor, and capital) whose services they rent or sell to firms or businesses through factor markets in exchange for factor payments (rental payments, wage payments, interest, and profits). Households use their factor income to purchase goods and services, capital goods. Households also use part of their factor income to pay government taxes.
75% of national income is received as wages and salaries. Part of the income goes to the government as personal taxes, and the rest is divided between personal consumption expenditures and personal saving. Economists define saving as " the part of after-tax income which is not consumed." Households have two choices with their income after taxes, to consume or save. The desire or willingness to save depends on the size of your income, if your income is low, you may dissave. Saving and consumption vary directly with income, as the households get more income, they divide it between saving and consumption.
Households offer labor service as a factor of production and businesses repay them with income or salaries. The fact that households consume a certain portion of total income, does not guarantee they will consume the proportion of any change in income they might receive. The proportion or fraction, of any change in income consumed is called the marginal propensity to consume. MPC is the change in consumption divided by the change in income. The marginal propensity to save, MPS is the ratio of change in saving to the change in income. The sum of MPC and MPS for any change in disposable income must always be one. As households save a portion of their income into the
financial market, the financial market distributes to households interest accrued on the money saved. The financial market is a market that trades financial assets. Financial assets are the legal claims on the real assets in our economy including corporate stocks and bonds, government securities, and money. Without financial markets it would be impossible to accumulate the funds needed for investment in capital projects. Firms or businesses employ factors of production, which they obtain from households through the factor markets in exchange for factor payments. They use factors to produce goods and services, which are sold to households and the government sector through the goods and services markets. The revenue from these sales goes to households as factor payments or to the government as taxes. The government sector purchases output from firms through the goods and services markets, financing these purchases by tax collections.